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On Our Radar

Will the Federal Reserve Raise Interest Rates Next Week?

One of the most important things that will happen in the market next week is the Federal Reserve's announcement about whether it will raise interest rates for the third time this year. But while the economy continues to slowly mend -- which favors higher rates -- few people expect the central bank to hike the fed funds rate anytime soon.

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According to CME Group's FedWatch Tool, which uses activity in the futures market to estimate the probability of a rate rise at each of the Fed's next eight meetings, there's a 98.6% likelihood that rates will stay right where they are now next week. The current target range for the fed funds rate, which is the primary short-term interest-rate benchmark in the United States, is 1% to 1.25%.

The same is true for the Fed's next meeting, as well. CME Group estimates that there's only a 3.9% probability of a rate rise in November. It isn't until the final meeting of the year of the Federal Open Market Committee that this changes, with a probability of just over 50% in favor of a 25-basis-point boost to rates in December.

While the Fed has now raised rates four times since the financial crisis, in the wake of the target fed-funds rate dropping to 0%, it's been reluctant to hike rates too rapidly. The economy has reached full employment, with an unemployment rate of only 4.4%. But the second prong of the Fed's so-called dual mandate has not cooperated, with inflation stubbornly remaining below the 2% threshold desired by monetary policymakers.

The good news is that inflation seems to be picking up. The government reported today that consumer prices increased 0.4% in August over July, and by 1.9% compared to the year-ago period. If you exclude the impact of food and energy, which vary widely and exert an outsized influence on consumer prices more broadly, so-called core consumer prices rose 1.7% last month compared to August 2016. The report snapped a five-month streak of weaker-than-expected readings.

Banks would be the biggest beneficiaries of an interest-rate increase. Bank of America(NYSE: BAC) estimates that a 100-basis-point, or 1 percentage point, increase in short- and long-term rates would translate into an added $3.2 billion in annual net interest income. The same number for JPMorgan Chase (NYSE: JPM), the nation's biggest bank by assets, is $2.2 billion.

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To be clear, even if the Fed were to hike the fed funds rate, it would most likely do so by only 25 basis points, not the full 100 basis points cited by these banks in their interest-rate sensitivity analyses.

Shares of banks were nevertheless down in afternoon trading on Thursday following the upbeat report on inflation. Bank of America's shares fell 20 basis points, while JPMorgan Chase's stock was off by 30 basis points. Meanwhile, the KBW Bank Index, which tracks shares of two dozen large-cap banks including Bank of America and JPMorgan Chase, was lower by a similar amount.

In short, there seems to be little possibility that the central bank will raise rates at its meeting next week. If the economy continues to mend and inflation heads higher, however, it's only a matter of time before the central bank does so.

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